Kiwi Property Group Limited (KPG) Earnings Call Transcript & Summary

Good day and thank you for standing by. Welcome to Kiwi Property FY '24 Annual Results Webcast Conference Call. [Operator Instructions] Please be advised that today's conference call is being recorded. I would now like to hand the conference over to your first speaker today, Clive Mackenzie, Chief Executive Officer. Please go ahead.

Thank you, Maggie. Kia ora and good morning, everyone and thank you for joining us for Kiwi Property's annual results webcast for the year-ended 31 March 2024. I'm Clive Mackenzie, the CEO of Kiwi Property and today I'm joined by Steve Penney, our Chief Financial Officer; and Cam Hodgetts, our Head of Investor Relations. I assume you all have a copy of our presentation in front of you. If not, you can access one from the results section of our website at kp.co.nz. A quick reminder that as usual, we have included detailed financial and property slides the [ appendices ] to the annual results presentation. I'll take the disclaimer as read, so please turn to Slide 5. Kiwi Property has a comprehensive strategy designed to drive superior returns for investors over time through the company's ownership, development and management of a quality real estate portfolio. While high interest rates and a soft economy made FY '24 challenging in many respects, we nonetheless made substantial progress on several key initiatives, bringing us closer to our ambition of being New Zealand's leading creator of retail-led mixed-use communities at key transport nodes. This year, we took steps towards bringing residential accommodation to life at Sylvia Park with the construction of Resido, our 295 apartment build-to-rent development, which is now just a week away from completion. Leading Australian flexible accommodation provider Urban Rest will lease 12% of apartments in the complex, providing guaranteed income and helping us test demand for short-stay accommodation at Sylvia Park. In parallel, the lease-up of 3 Te Kehu Way is now 96% complete with ASB recently signing an agreement to rent over 1,700 square meters of floor space in the building. The bank joins other blue-chip corporates, such as ANZ and IAG, which also have a significant presence at Sylvia Park. This reflects the quality of tenants seeking commercial space in the precinct, attracted by its amenities, location and sustainability credentials. In FY '24, our tenant Net Promoter Score increased 11 basis points, reflecting the continued value we offer to customers across our diversified portfolio. Our focus on winning with customers has enabled us to attract and retain leading retailers and office tenants and maintain occupancy at over 99% despite the tough post-COVID conditions. One of the major projects undertaken by the business this year was the rollout of our new Yardi enterprise IT platform. The deployment was completed on time and budget and is already helping to reduce costs and enhance business performance. We've been able to drive efficiency post the Yardi deployment, including a roughly 9% decrease in headcount. Employment and admin expenses are flat on last year despite incurring around $1 million in additional redundancy costs and one-off payments and a further $1 million in extra software implementation charges. Finally, as many of you are no doubt aware, 2 weeks ago, we also announced that we have conditionally sold the Vero Centre to a Hong Kong, China-based institutional investor for $458 million. The deal is a good example of our capital recycling program in action. Turning now to Slide 6. We're pleased to have made progress on several of our long-term big bets such as the Vero Centre sale. However, we equally focused on maximizing the day-to-day operational performance of our assets. As you can see on this slide, we completed almost 590 leasing transactions in FY '24, achieving a 4.4% increase in total leasing spreads. New leases were particularly strong, driving a 5.3% uplift overall, with office up an impressive 18.7%, driven by new deals at the Vero Centre, where we took advantage of the Bell Gully backfill to reset rents. These figures demonstrate the flight to quality currently happening in the office market and the rise of hub-and-spoke office locations such as Sylvia Park. Tenants are demanding premium buildings with great amenities and excellent locations. We're well placed to meet those requirements, putting us in a good position to drive further rental growth over the coming years. Turning now to Slide 7. Retail spending has cooled in New Zealand over recent months, with figures released by Stats NZ showing that electronic card transactions were down 3% in March 2024 compared to the same time last year. Despite this general contraction, Kiwi Property sales rose 1.4% in FY '24, reaching $2.1 billion, with pedestrian counts up 2.3 million in a continued rebound post COVID-19. Active remixing and the opening of new stores, such as JB Hi-Fi and Mecca saw sales increase 13.1% at The Base Te Awa. LynnMall sales rose 1.8%, fueled by the arrival of JD Sports and the center's 60th anniversary marketing campaign. Sylvia Park precinct sales were flat following significant growth over recent periods, but remained well ahead of pre-COVID figures. While customers wallets are under pressure in the current financial climate and retail sales have moderated over recent months, we believe that our leading portfolio of retail-led mixed-use assets is well placed to bounce back strongly as cost of living pressures subside. On now to Slide 8. The fair value of our property portfolio overcame the highest interest rate environment to hold firm in the 6 months to 31 March 2024, posting a fair value increase of 0.1%, or $3.3 million for the period. Mixed use was the most resilient of our portfolios, with robust sales and broadly flat capitalization rates, resulting in a circa $16 million fair value gain. Pleasingly, the fair value of the Sylvia Park precinct increased by 1.5% over the past 6 months, reflecting its standing as one of the country's leading property assets and also demonstrating the defensive benefits of mixed use, particularly in terms of diversifying risk during challenging economic conditions. The fair value of our CBD office portfolio declined 2% over the last 6 months, driven by the headwinds facing the sector. Based on Kiwi Property's current discount to NTA, the market has priced in further write-downs of our property portfolio. The conditional sale of the Vero Centre close to book value suggests those concerns are overdone and we are confident the value of our assets will remain stable as interest rates pass their cyclical peak. Turning now to Slide 9. Reducing corporate costs is a priority for the business. Over the past couple of years, we faced increased overheads related to the Yardi IT deployment. However, with the project now complete, those costs will begin to normalize. The productivity benefits flowing from the Yardi rollout, coupled with a range of other HR initiatives, enabled us to deliver a head count reduction of 9% in FY '24. Through a combination of technology and continuous business improvement, we believe there is scope for further efficiency gains, enabling us to achieve more with less. The full financial benefit of our cost savings measures is expected to be realized from FY '25, including a $2.9 million decrease in people-related costs through lower wage expenses and the removal of life insurance and employee share benefits. Our aim is to reduce management expenses as a percentage of net rental income, including property management revenue to FY '22 levels, equivalent to around 14.3%. Turning now to Slide 10. Almost 2 weeks ago, we announced the conditional sale of the Vero Centre in Auckland to a listed Hong Kong, China-based institutional investor for $458 million. The purchase price represents a 1.9% discount to the asset's September 2023 valuation and delivers a property level return from inception of 11%. Vero Centre is a good asset and has been a cornerstone of our CBD office portfolio for around 20 years. But given our focus on creating retail-led mixed-use centers, it is no longer core to our strategy. The sale is subject to Overseas Investment Office approval. But presuming it settles, the proceeds will initially be used to repay bank debt, reducing our pro forma gearing by approximately 10 percentage points to 27%, which is comfortably within our self-imposed gearing range. This additional headroom unlocks plenty of options for the company and will enable us to examine opportunities to grow earnings and increase shareholder value. Turning to Slide 11. We made pleasing progress on our sustainability strategy in FY '24, earning some important sustainability ratings in the process. Firstly, 3 Te Kehu Way was awarded the country's first 6-Green Star Design & As Built rating, highlighting its outstanding environmental credentials. Our entire office portfolio now has a minimum NABERSNZ rating of 4 stars, highlighting the sustainability performance of our commercial assets as we continue seeking opportunities to optimize our properties' environmental and operational standing. In the retail space, Sylvia Park was awarded a 6-Star NABERS indicative pilot energy rating in November. As NABERS ratings aren't currently available for shopping centers in this country, we've been working with partners in Australia to bring this to fruition and are proud to be leading the charge for retail landlords in New Zealand. And finally, we increased Sylvia Park's on-site renewable energy capacity with the addition of a new solar array that enabled us to generate over 1.3 million kilowatt hours of power across the precinct in FY '24, providing enough electricity to power 50% of the shopping center's entire common areas. I'd now like to hand over to Steve to discuss our annual financial results beginning on Slide 13.

Thanks, Clive, and good morning, everyone. Over recent periods, we've continued to rebalance our portfolio towards assets that we expect to be more resilient and perform better over time. The divestment of Northlands Westgate Lifestyle and 44 The Terrace has unsurprisingly seen Kiwi Property's earnings decrease from the same time last year, with net rental income declining 9.2% to $184.9 million. Operating profit before tax was also impacted by divestments declining 16.5% to $108.2 million, while adjusted funds from operations contracted 14.3% to $99.8 million. When viewed on a like-for-like basis to account for the impact of the asset sales and prior-year release of COVID-19 accruals, however we see that the net rental income increased by 5.8% or $10.2 million, while operating profit before tax decreased by $5 million or 4.4% and adjusted funds from operations was down $1.5 million or 1.5%. The relative stability of our valuations contributed to similar stability in our net profit, which declined by a marginal $2.1 million in FY '24. While our capital recycling program has caused a temporary decrease in income, by selling our non-core assets and reinvesting the proceeds into new opportunities, we will help create a higher-quality asset base and improve long-term returns for our shareholders. Turning now to Slide14. As Clive mentioned, Kiwi Property achieved rental growth of 4.4% compared to the same time last year, with new leases up 5.3% and rent reviews 4.2%. We saw a substantial uplift in leasing spreads for new lease deals across the mixed-use portfolio led by The Base and Sylvia Park precinct at 7.7% and 6.2%, respectively. Portfolio occupancy increased marginally to 99.3% at the end of FY '24 when our office assets were fully occupied. Since then, Bell Gully has left the Vero Centre. However, 3 of its 5 former floors have already been released, with the remainder under advanced negotiations. The firm's departure creates an excellent opportunity to reset rents and divide the space into new configurations that appeal to a wide range of new tenants. The weighted average lease expiry across our portfolio was 4 years at the end of FY '24, slightly down on the year before. Turning now to Slide 15. We undertook several capital management activities in FY '24, including successfully raising the gearing covenants of our KPG030, 40, and 50 series bonds from 45% to 50% in October 2023, bringing the company's debt covenants into line with the market. In November, we undertook a debt refinancing holding bank facilities at $950 million and maintaining our margins despite the rising margin environment. As part of this exercise, we added ICBC to our group of banking partners, offering further optionality and funding diversity. At year-end, our weighted average cost of debt was 5.61%, up from 5.18% in FY '23, reflecting the rising interest rate environment, while our weighted average term to debt maturity was a healthy 3.6 years at the end of the year. Our gearing increased slightly from 35% to 37% in FY '24. While this is currently above our self-imposed target range, following the completion of the conditional Vero sale, this figure will reduce to around 27% on a pro forma basis, comfortably within the band. I'll now hand back to Clive, who will resume on Slide 16.

Thanks, Steve. Around 5 years ago, I began speaking about a new residential asset class called build-to-rent or BTR. At the time, I said it had the potential to play a valuable role in New Zealand's housing solution and become an important component of Kiwi Property's mixed-use strategy. Today, I remain convinced that both of these things are true. BTR has already experienced rapid growth in markets such as the U.K. and Australia, and we believe the conditions are right for to do the same in New Zealand. The rise in net migration, coupled with the decline in residential construction is contributing to an imbalance between supply and demand in the housing market, making homes more expensive and renting increasingly commonplace. More than 50% of Aucklanders over 15 already live in rental accommodation, with this figure expected to increase to 60% by 2043. As the need for rental accommodation grows, we see significant potential for BTR to play a role in addressing the shortfall. Importantly, though, while some people will rent due to housing affordability challenges, BTR isn't about low-cost accommodation. For many people, BTR will become the first choice providing flexibility, stability and amenity while enabling them to free up capital or save for a house deposit. We expect these tenants to provide the foundation of our tenant population. On to Slide 17. I'm delighted to advise that our first BTR project, Resido, is almost complete. Three of the development's 4 buildings are now complete and the last is due to be finished on the 4th of June. Resido's launch is a crucial milestone on Kiwi Property's mixed-use journey and will bring residential accommodation to Sylvia Park for the first time. It's been a huge effort to get to this point, and I'd like to thank everyone who has worked so hard to make Resido a reality. Leasing of Resido is now underway with strong initial interest, fueled by a comprehensive marketing campaign that spans Trade Me, billboards, digital and PR. We've already conducted over 50 tours and will report tenant progress at periodic intervals to help keep the market up-to-date on our progress. Our ambition is to have Resido let within the next 12 to 18 months. In February, we announced that leading Australian flexible accommodation provider, Urban Rest has agreed to rent 12% of Resido or 34 apartments, for at least the next 3 years. The deal delivers guaranteed income from day 1, helping to derisk the project while simultaneously giving us the ability to test the success of the short-stay model at Sylvia Park. On to Slide 18. On this slide, you'll see the various metrics for Resido. I won't go through each of them, but I did want to call out a few things. First of all, as we previously signaled, once complete, the project's total cost is expected to be $240 million, up around 8% from launch due to cost inflation. Despite this, Resido is forecast to deliver a stabilized yield of between 4.75% and 5.25%, while the anticipated IRR is 8% to 8.5%, broadly in line with the returns generated from BTR by REITs in Australia and marginally ahead of earlier forecasts. On this slide, you can see the numbers we're targeting for each apartment configuration, with 1 bedroom apartment starting from $690 per week and 2 bedrooms from $885 per week. These rents were determined by setting a selection of similar standard apartment buildings across Auckland. We believe we've got them right. However, ultimately, it will be up to the market to decide. Our focus is on being responsive while continuing to optimize the outcome for our business and our shareholders. Turning now to Slide 19. Kiwi Property's ambition is to be New Zealand's leading creator and curator of retail-led mixed-use communities. Nowhere is that ambition coming to life more clearly than at Sylvia Park. The opening of Resido marks the culmination of phase 1 of the asset's transformation from a shopping mall to a world-class mixed-use asset. We began this journey several years ago with the opening of ANZ Raranga and since then we have added a second office building at 3 Te Kehu Way, 20,000 square meters of galleria retail, a refurbished dining precinct and now 295 residential apartments. In addition, New Zealand's first IKEA store is currently under construction. We've achieved a considerable amount at Sylvia Park. But as you can see from this 30-year master plan, the options ahead of us are extensive. As we continue to progress Sylvia Park, we'll focus on achieving the highest and best use for each square meter of our strategic landholding as we grow and diversify the revenue from the site and drive further valuation uplift. On now to Slide 20. We've continued to make good progress at Drury through FY '24 and Stage 1 earthworks. Earthworks are now almost complete, with civil works expected to begin in the next few months. We're currently in advanced negotiations with several local and international large format retailers regarding potential site sales, and we hope to be able to provide more detail on those transactions soon. Our objective is to sell down the LFR and super lot sites and use the proceeds to fund the infrastructure for Drury Stage 2. There's a high degree of interest from potential tenants, which recognize Drury's significant potential. We're looking forward to capitalizing on that interest and in the process, unlock returns for the business and our shareholders. The numbers on the right show the anticipated return from the Drury project. The development is forecast to deliver an IRR of between 15% and 20% on stage 1 land development and 8% to 12% as we move into the creation of the town center at stage 2. The estimated AFFO impact on Drury between FY '26 and FY '29 is expected to be between a positive [ $0.005 and $0.006 ] per share. Turning now to Slide 22. Kiwi Property will pay a quarterly dividend of $0.01425 per share for the Q4 FY '24, taking the full year dividend to $0.057 per share. Looking ahead to FY '25, we expect to pay a full year dividend of $0.0540 per share and within the range of 90% to 100% of AFFO. This is a 5.3% reduction compared to FY '24, driven primarily by high interest rates and the impact -- the financial impact of the government's change to tax policy, removing our ability to claim depreciation on commercial buildings. Despite this reduction, we remain committed to delivering earnings growth fueled by Resido rental income, additional revenue from a fully leased 3 Te Kehu Way and Drury land sales, among other things. As always, dividend guidance and payments are contingent on the company's performance and barring material adverse events or unforeseen circumstances. Turning now to Slide 23. Kiwi Property delivered a robust operating result in FY '24 and took important steps forward in the delivery of our strategy. Heading into FY '25, we have 4 key business priorities. First, we will proceed with leasing up Resido, aiming to have the building tenanted within 12 to 18 months and deliver returns in line with those I outlined earlier. Secondly, we'll strive to complete the Vero Centre transaction and in the process, deliver the funds to pay down debt, reduce our gearing and create the headroom to pursue accretive new opportunities. Thirdly, we will look to sell LFR sites at Drury, unlocking the proceeds to accelerate the development of stage 2 and the returns that go with it. And finally, we will drive operational excellence across our high-quality asset portfolio, focusing on cost control, growing rents and driving sales. We're extremely conscious of the current period of economic volatility and we will adapt a highly disciplined approach to the operation of our business in FY '25, delivering on strategy, driving asset performance and strictly managing our balance sheet. By focusing on these things, we'll put ourselves in the best position to navigate the current downturn and deliver returns for shareholders as conditions normalize. Thank you all for joining today. That concludes my overview of our FY '24 annual results. I'll now pass over to the moderator, Maggie who will open the phone lines for questions. Thank you.

[Operator Instructions] Our next question comes from Nicholas Hill of Craigs Investment Partners.

Just looking at the direct cost control slides and we have the new Yardi implementation and direct costs. You said that you're expecting your management expenses as a percentage of net property income to go from sort of like 17% to 14%. But this looks like it's net of direct operating expenses, which have bounced around quite a bit. That kind of implies that I guess you're sort of expecting these -- this line item to remain steady as a percentage of total property revenue going forward. Would that be a fair assumption to make? And could you also sort of talk to, like, why this line item has moved around a bit?

I'll hand this one over to Steve.

Sorry, Nick, just to be clear, you're talking about the employment and admin expenses?

Yes. And also the direct operating expenses above? Yes.

Yes, yes. So the direct operating expenses have moved around between '23 and '24 because there's some COVID accruals that have been released into direct property expenses in the prior year. So that's about that $5.7 million. So that's officially, if you like, pushing that number down. That's why that's bouncing around a bit. We've done some further analysis in there and the inflationary impact of -- and when we strip out asset sales is about $3.5 million. So those direct operating expenses are moving consistent with inflation.

Okay. The fair value of Sylvia Park increasing 1.5% over the last 6 months caught my eye. Would it be possible to talk to what the assumptions were behind this value increase and what was the corresponding evidence to support this?

I might give you a little update, and then Steve can jump in if he wants to. Effectively, the mixed-use asset, or the retail component of it, the cap rate had a marginal movement through this period, but really it was off the back of strong rental growth that we were able to get that lift.

Okay. And then in terms of like, allocating the proceeds of the Vero Centre sale, would it be possible to give a high level -- or talk to a high level in terms of what the reinvesting other -- or investing in other initiatives may look like?

Primarily, we'll use it to -- yes, sorry -- primarily, we'll use it to pay down debt. But basically, as we go into the second part of the cycle, there inevitably may be opportunities that the company may want to look at down the line. But also, we've got an extensive development program that obviously the market is fully aware of, particularly at Drury and some other of our development sites. So that gives us the firepower when the time is right to be able to deploy that capital.

Okay. And then last one, just on sort of releasing the Vero Centre, you said that 3 floors have been released and 2 of the 5 are under advanced negotiations. How advanced are these renegotiations? And in terms of sort of what the incoming tenants are, what their profile is? Are you sort of like having to carve up the floors to smaller floor plates? And if so, sort of, how are you capturing that spend into the rental income?

Yes. So the 3 floors that were leased were leased on a whole floor basis to each -- to 3 different tenants. So it was on a floor by floor basis. The last 2 remaining floors actually have a stair interconnection. So we've been looking to maximize that at the moment. But if we're unable to maximize that, then we will carve it up into probably floor by floor or maybe even smaller. But at this stage, the tenants that we have interest are -- some of them are on a 2-floor basis and some are on a floor by floor. So we're just working through that process at the moment to decide what's the best outcome for us.

[Operator Instructions] Our next question comes from Rohan Koreman-Smit from Forsyth Barr.

I do wonder if there's a few people on the Ryman call just given you've got both calls going on at the same time and a few crossover analysts. But I'll just follow on from Nick with Vero. What have you assumed around Vero, I guess, sale date in your guidance? And then what sort of depreciation recovered figure should we be looking for in AFFO?

I'll hand this one over to Steve.

Yes, sure. So the sale of Vero is sort of broadly neutral in terms of guidance. So it doesn't have an impact either way or immaterial. And depreciation recovered is $8 million.

Is that within the current -- so when you talk to kind of current dividends, $0.0540, 80% to 90% -- 90% to 100% payout, is that implied AFFO range including that $8 million?